Thursday, 29 September 2016

Why does society no longer blame immigrants for spreading disease? It
used to. The Jews were blamed for the Black Death, and Irish
immigrant workers were blamed for Cholera in the 1830s. (See this
nice science museum website.) Syphilis has been blamed on all manner
of foreigners: the French blamed the Italians and the Italians blamed
the French! The obvious answer is that society now knows better as a
result of medical science.

Nowadays immigrants are instead blamed for unemployment, lower wages
and increasing crime. They are blamed
for reducing natives access to the NHS. Yet just as in the case of
immigrants and disease, most experts know that popular concerns are
wide of the mark. Nor are some of the sources of popular
misperception difficult to understand. For example immigrants use the
NHS, but they also pay taxes that allow us to fund more NHS
resources, but government funding may be slow in responding to
changes in local demand. In current circumstances the UK government
is holding back
those resources nationally, but says it is ‘protecting’ the NHS
and the media dutifully repeats that they are.

Some politicians and large sections of the print media deliberately
fuel popular misconceptions because they can use it to their
advantage. Others feel they have to go with those misperceptions
because otherwise they will lose votes. Much of the broadcast media
see it as their duty to ‘reflect popular concern’ but feel less
compelled to reflect expert opinion. But if you think this is
inevitable and natural, imagine what would happen if a senior
politician started blaming immigrants for bringing in diseases. Well
you don’t have to imagine.

Watching certain
Labour politicians trying to get on to the anti-immigration bandwagon
is painful to see. Some are the same politicians who also argued that
Labour had to accept austerity after the 2015 General Election. Now
immigration is much more complex than austerity, as I discuss here,
but that is all the more reason to respect the evidence. (Those who
still wonder why Jeremy Corbyn is so popular among party members
should note he is sticking with his principles on both austerity and
immigration.) But I think it is wrong to just blame politicians.
Responsibility must also rest with most of the media, who (as we saw
in the Brexit campaign) treat economic evidence very differently from
medical evidence.

Wednesday, 28 September 2016

Duncan Weldon asks
whatever happened to deficit bias, and why
was austerity so popular when it seems to hurt two crucial groups of
electors. They are both excellent questions.

First, a quick recap of Duncan’s arguments. The standard view among
economists before the financial crisis was that economies were prone
to deficit bias: a tendency for government budget deficits and
debt (as a share of GDP) to slowly increase. [1] Although there are a
number of theories about why deficit bias occurs, several involve
voters being at best unconcerned about it, and at worst conniving in
it. Such theories are miles away from an electorate giving strong
support to a government campaigning on reducing the deficit.

Second, austerity keeps interest rates low. So not only does
austerity hit wages and profits, but it also hits those who rely on
interest income to supplement their pension, a group who in case you
need reminding have a high propensity to vote. Although asset values
have gone up as well, many in this group will be reluctant or unable
to turn this into income.

I try and answer both questions in this paper.
As with many things, I think the answer lies in the financial crisis.
Popular concern about government deficits will be much greater if
these deficits are at 'record levels', which they inevitably were
following the deepest global recession since WWII. A recession
initiated by a financial crisis is also likely to see consumers
reducing their own borrowing, and so (erroneous) analogies between
governments and households resonate. A recession initiated by a
financial crisis also makes the public receptive to the potential
power of these markets, and therefore to claims by those ‘close to
the markets’ that national disaster is just one more large deficit
away. Arguments from economists that rational markets would not be
concerned about government default when the central bank can create
money are met with a widespread belief that the recent crisis shows
markets are not necessarily rational. Markets become like a powerful
god who can only be appeased by the sacrifices prescribed by its
priests.

This is how, in the case of the UK, George Osborne was able to
redefine the goal of macroeconomic policy from the normal desire to
see higher living standards into the need to reduce the deficit. His
motives for doing so may have involved a
desire to reduce the size of the state, what I call deficit deceit, but uppermost in his mind was
that his strategy was popular. So popular, both among the electorate
and the media, that the Labour opposition eventually gave up on
arguing that there was an alternative.

A key corollary of all this is that the popular appeal of austerity
has a sell by date. Once people have stopped paying off their own
excess debt, market panic becomes a more distant memory, and the need
to control the government’s deficit seems less compelling. The
underlying factors that created deficit bias can resurface. Quite
when that sell by date will be depends on particular national
circumstances. In the UK the game was up when the country voted for
Brexit, but I suspect even without that austerity would not have won
the Conservatives two elections. So the popularity of austerity is
short term.

As to the political economy question, I think that be a genuine puzzle if austerity was a long term phenomenon. But as it is not we
need to bring in (hopefully) short term failures of knowledge and
information. I have not noticed campaigns to ‘save our savers’
also arguing for less austerity, and I suspect the reason is because
they just do not see the connection. Who makes that connection for
them? Here
is Chris Dillow complaining that the media just does not do this kind
of thing. Central banks should, but for their own reasons rarely do. People may not act in
their own self-interest if they do not know what is in their own
interest, and in the short term at least this knowledge may not be
made available to them.

[1] To preempt the
usual MMT comments, this bias relates to economies where monetary
policy takes care of output and inflation stabilisation.

Monday, 26 September 2016

We have already begun to hear laments that Corbyn’s second victory
means the end of Labour as a broad church. This is nonsense, unless
that church is one where only people from the right and centre of the
party are allowed to be its priests. Alison Charlton (@alicharlo)
responded to my tweet to that effect by saying “It's the soft left,
like me, who shouldn't be priests. We're rubbish at it.”

That I think captured my thoughts this last weekend. As Steve
Richards writes
“The so-called shadow cabinet rebels must be the most strategically
inept political group in the history of British politics.” And
although they were never the tightly knit group of coup plotters that
some Corbyn supporters imagined, their collective thinking was
completely flawed. It was self-indulgent folly by the minority group that I
call the anti-Corbynistas to constantly spin against Corbyn from the
start: as I predicted,
it was totally counterproductive. But it was equally naive of
centre-left MPs who nominated Owen Smith to believe that all they
needed to do was adopt the leadership’s economics policies.

Forget all you read about Smith not being experienced enough, or
about how he made gaffes (journalists just love gaffes), how he could
have run a better campaign and so on. This is stuff and nonsense.
Just as with Sanders in the US, Corbyn’s support is the result of a
financial crisis the after effects of which we are still suffering
from and where the perpetrators have got away largely unscathed. The
crisis came as a complete surprise to the political centre, and only
those on the left had warned about growing financialisation. Yet
these warnings went unheeded by the Labour party, in part because the
left had become marginalised. That is why politicians like Sanders
and Corbyn can talk about the financial crisis with a conviction that
others cannot match, and their supporters see that. The constant UK
refrain about entryism is, frankly, pathetic.

In those circumstances Owen Smith had a mountain to climb. I wrote
on 1st August a list of things he needed to do to win. Crucially he
failed to back reducing the number of MPs required to nominate a
candidate for leader, which in practice excluded any successor to
Corbyn from the left being able to run. I wrote “If Smith wants
Labour members to trust him, he has to show that he also trusts them
in the future.” I also suggested he should now offer John McDonnell
the job of shadow chancellor to show he meant to unify the party. How
naive I was, some retorted: didn’t I know McDonnell was hated by
much of the PLP. Of course I knew, which was partly why it was a good
idea: at least I was trying to show some imagination that seemed
absent from the PLP. Team Smith even seemed unable to acknowledge
McDonnell’s positive achievements, like the Economic Advisory
Council (EAC) and the fiscal credibility rule. No wonder he lost.

There is no getting away from the fact that the vote of no confidence
is going to be fatal to Labour’s chances at the General Election.
Of course Corbyn’s performance had been extremely poor, and he ran
a deeply flawed Brexit campaign. But the no confidence vote was a do
or die act, and the chances of it succeeding were always minimal.
That is political ineptitude: sacrificing your party’s election
chances for slender odds. All MPs can do now is help minimise the
scale of that defeat, and if some feel that given all that they have
said about the leadership that is best done from the backbenches
Corbyn supporters should respect that. They should use the spare time
to think about how to revitalise the centre left, but keep these and
other thoughts out of the public eye. Talk
of sacrificing being part of the single market so we can end freedom
of movement is not a good start. As Chris Dillow argues,
they are not even worthy of the label Blairite.

What Corbyn needs to do is clearly set out by Owen Jones here.
To say he has a mountain to climb is an understatement. He carries
the weight of the no confidence vote. Even if the PLP now unites
behind him, much of the media will act as if it does not. He risks
being outflanked in the traditional heartlands by UKIP: if voters
think their problems really would be reduced with less immigration
(and which politicians are telling them otherwise?), they will vote
for the party that talks about little else. In the new heartlands of
London and other cities, anti-Brexit feeling may well find LibDem
clarity on the issue attractive. (Corbyn’s margin of victory in
London was small.) Corbyn's ridiculing of warnings about the economic cost
of Brexit (despite the advice of his EAC)
does not set him up well to capitalise on any bad economic news.In short, if he manages to defeat the Conservatives in 2020 it will
be one of the most remarkable achievements in UK political history.
Even to come close would be a great success. For what it is worth I
hope he does, if only because it would force the centre-left to
finally recognise their failure since the financial crisis.

Saturday, 24 September 2016

This post has its genesis in a short twitter exchange storified
by Brad DeLong

DSGE models, the models that mainstream macroeconomists use to model
the business cycle, are built on the foundations of the Real Business Cycle (RBC) model. We
(almost) all know that the RBC project failed. So how can anything
built on these foundations be acceptable? As Donald Trump might say,
what is going on here?

The basic RBC model contains a production function relating output to
capital (owned by individuals) and labour plus a stochastic element
representing technical progress, an identity relating investment and
capital, a national income identity giving output as the sum of
consumption and investment, marginal productivity conditions (from
profit maximisation by perfectly competitive representative firms)
giving the real wage and real interest rate, and the representative
consumer’s optimisation problem for consumption, labour supply and
capital. (See here,
for example.)

What is the really big problem with this model? Not problems along
the lines of ‘I would want to add this’, but more problems like I
would not even start from here. Let’s ignore capital, because in
the bare bones New Keynesian model capital does not appear. If you
were to say giving primacy to shocks to technical progress I would
agree that is a big problem: all the behavioural equations should
contain stochastic elements which can also shock this economy, but
New Keynesian models do this to varying degrees. If you were to say
the assumption of labour market clearing I would also agree that is a
big problem.

However none of the above is the biggest problem in my view. The
biggest problem is the assumption of continuous goods market clearing
aka fully flexible prices. That is the assumption that tells you
monetary policy has no impact on real variables. Now an RBC modeller
might say in response how do you know that? Surely it makes sense to
see whether a model that does assume price flexibility could generate
something like business cycles?

The answer to that question is no, it does not. It does not because
we know it cannot for a simple reason: unemployment in recessions is
involuntary, and this model cannot generate involuntary unemployment,
but only voluntary variations in labour supply as a result of short
term movements in the real wage. Once you accept that higher
unemployment in recessions is involuntary (and the evidence for that
is very strong), the RBC project was never going to work.

So how did RBC models ever get off the ground? Because the New
Classical revolution said everything we knew before that revolution
should be discounted because it did not use the right methodology.
And also because the right methodology - the microfoundations
methodology - allowed the researcher to select what evidence (micro
or macro) was admissible. That, in turn, is why the microfoundations
methodology has to be central to any critique of modern macro. Why RBC modellers chose to dismiss the evidence on involuntary unemployment I will leave as an exercise for the reader.

The New Keynesian (NK) model, although it may have just added one
equation to the RBC model, did something which corrected its central
failure: the failure to acknowledge the pre-revolution wisdom about
what causes business cycles and what you had to do to combat them. In
that sense its break from its RBC heritage was profound. Is New
Keynesian analysis still hampered by its RBC parentage? The answer is
complex (see here),
but can be summarised as no and yes. But once again, I would argue
that what holds back modern macro much more is its reliance on its
particular methodology.

One final point. Many people outside mainstream macro feel happy to
describe DSGE modelling as a degenerative research strategy. I think
that is a very difficult claim to substantiate, and is hardly going
to convince mainstream macroeconomists. The claim I want to make
is much weaker, and that is that there is no good reason why
microfoundations modelling should be the only research strategy
employed by academic economists. I challenge anyone to argue against
my claim.

Friday, 23 September 2016

In the last few months I have sometimes been told that the last
Labour government did nothing to reverse the rise of inequality seen
under the previous Conservative administration. It is a serious
charge, given the harm
that inequality creates. But it is also incorrect, and here is a nice
chart that shows why.

The Gini coefficient measures inequality. The black line looks at
incomes, but the grey line looks at full time earnings. It shows that
inequality in earnings was rising throughout the period, including
when Labour was in power. Inequality of incomes was flatter while
Labour was in power.

The chart is taken from a paper
by Mike Brewer and Liam Wren-Lewis (short summary here).
The authors use microdata to explain these divergent trends in the
1990s and 2000s. They find four factors at work.

“First, inequality between those with different employment statuses
has fallen, primarily due to a fall in the number of unemployed.
Second, employment taxes have played a larger role since 1991 in
mitigating the increase in inequality of gross employment income than
they did before 1991. Third, investment income has contributed less
to total income inequality since 1991, largely due to the decline in
its importance as an income source. Finally, a rise in the relative
incomes of pensioners and households with children under five –
both groups that benefited from reforms to welfare benefits and tax
credits during the 1990s and (especially) 2000s – has pulled
inequality down. Overall, since 1991 these four factors have almost
entirely offset the impact on income inequality of the
inequality-increasing changes in the distribution of earnings and
self-employment income.”

Some
of these factors may not have owed much to government policy, but
others clearly did. The bottom line is that the last Labour
government did quite a lot to reduce inequality. Only once you
recognise that can you be realistic about what it would take to do
more. Here
are some ideas from Tony Atkinson, and I personally would be even
more radical
in one particular area.

Thursday, 22 September 2016

Matthew Bishop has a nice simple post
at SPERI suggesting how the ‘economy is like a household’ idea
can be tackled. He is correct that this analogy has tremendous power,
to the extent that I doubt we would have seen so much UK austerity
without it. He uses an exchange between Yanis Varoufakis and a member
of the Question Time audience to suggest that attempts to simply
explain the economics are ineffective. He suggests that the “problem,
as Jonathan Hopkin and Ben Rosamond have suggested (here
and here),
is that you cannot fight ‘political bullshit’ with facts”.

I want to make some
observations, in ascending order of importance.

I think he is right that
economists can usefully point out that households do not always
balance their budgets. But all the examples he gives help explain
why it may make sense for the government to borrow to invest. Indeed
he could have added comparisons between governments and firms in
this respect. That is why it is easy for economists to now argue
that governments should be borrowing more to invest. I’m sure most
economists would use exactly these analogies: after all most do try
to teach this stuff.

However these analogies do
little for the issue the audience member thought we were dealing
with. He thought the analogy was exactly the case of spending too
much on excessive drinking, and needing to sober up financially.
While the examples Matthew quotes get you over the simplistic idea
that governments should never borrow, they do not explain why (a) it
is OK in principle to keep the ratio of government debt to GDP
constant (governments live forever), and (b) why it makes sense for
governments to borrow a lot more in a recession (the automatic
stabilisers), or even (c) why the government should go out of its
way to borrow even more in a recession when interest rates are at
the Zero Lower Bound. We can try and get these ideas across as
simply as we can, as I have tried many times (and suggestions on how
to do it better are always welcome), but it is very difficult to do
so in a minute or two on Question Time. It is sufficiently difficult
that before the General Theory it was not understood by most
economists.

I think the suggestion that
economists are too busy trying to be correct and therefore too
scornful of simple analogies is a little unfair. Only a little: in a
live public appearance there is always the concern about what your
colleagues in the department will say afterwards. Economists are also aware, as Chris Dillow points
out, that partial analogies used in one context can easily backfire
in others. However I doubt very much that most economists do the
equivalent of mocking “every grammatical error made by friends
practising their holiday Spanish”.

The big difference between
economists and scientists at CERN is not that economists are less
respectful of lay people’s mistakes. It is (a) they have
politicians repeating false analogies about their subject as if they
were facts, and (b) large sections of the print media doing the
same, and (c) most of the rest of the media too clueless to
challenge these falsehoods.

This is why, for an evidence
based discipline like economics, the response ‘economists know
that the economy is not like a household in important respects and
here is why’ is not at the end of the day arrogant or dismissive.
If BrianCox
was asked on Question Time ‘what is all this about the Earth
moving: it is obvious that everything moves around the Earth’ we
would not blink an eyelid if he replied ‘No, scientists know that
is not true and it only seems that way to you because..’.

What austerity tells us, just
as the climate change denial tells us, is that in today’s world
respect for science is fragile. In the US public opinion about
climate change is sharply divided
along political lines, despite the near unanimity among scientists.
It is this that should really worry us, and not how climate change
scientists can better communicate with the public, desirable though
that might be in itself. A world where the scientist has to compete
on equal terms with the ignorant polemicist is not a healthy world.

Wednesday, 21 September 2016

I pointed
out two days ago that the real costs of Brexit are long term, which
unfortunately means that those who argued for Brexit will never be
held responsible in political terms for the damage it will do. As
John Springfordargues,
that also strengthens the hand of those arguing for a hard Brexit
(aka maximum damage). So who will speak for the 48%+ who want to
limit the damage?

Potentially the majority of MPs do. We have united opposition from
the SNP and LibDems. The great majority of Labour MPs also oppose
Brexit. Polly Toynbee suggests
this should become their unifying cause whatever the leadership does.
And of course around half of Conservative MPs probably voted, in a
personal capacity, to Remain. That has to be a worry for Theresa May,
which is why she has made it clear that MPs will have no effective
say in the Brexit negotiations.

So is this just going to amount to a lot of despairing and angry
complaints as the Brexiters do their worst. Not quite. There is one
source of opposition left standing (in the sense of having some power): Philip Hammond and H.M.Treasury.
The Treasury has always been the job Hammond wanted,
and not because he wanted to radically change that institution. It
should also not be forgotten that it was Treasury economists who
wrote the analysis suggesting the long run impact of Brexit on the UK
economy could be very large, and the larger the further away from the
single market we ended up being. Some will think this was a stitch-up
job to please Osborne, but I think that is extremely unlikely. After
all the Treasury analysis was pretty close
to other estimates, and it was overseen by Charlie Bean who is
excellent at judging what is academically kosher.

It is for this reason that we are already seeing headlines
talking about Hammond blocking Brexit ‘progress’. How much power
he has to do this will depend on the Prime Minister. If Theresa May
sides with her Brexit ministers against Hammond, as it seems
increasingly likely (see Martin Wolf here),
this will mark the end of a long period where the Treasury has
dominated economic policy in the UK.

That dominance started after a meeting in an Islington restaurant,
where Gordon Brown extracted the maximum price for standing aside in
favour of Tony Blair. The Treasury under Brown not only stopped Tony
Blair from adopting the Euro, but also exerted a control over the
economic aspects of other departments that had not been seen before.
Under the Coalition government Osborne and Cameron worked very
closely together, and the austerity strategy - supported by key
Treasury civil servants - dominated the domestic agenda. If May sidelines Hammond over Brexit, the Treasury will have moved
from dominance to playing second fiddle very quickly indeed.

Tuesday, 20 September 2016

It is a great irony that the microfoundations project, which was
meant to make macro just another application of microeconomics, has
left macroeconomics with very few friends among other economists. The
latest broadside
comes from Paul Romer. Yes it is unfair, and yes it is wide of the
mark in places, but it will not be ignored by those outside
mainstream macro. This is partly because he discusses issues on which
modern macro is extremely vulnerable.

The first is its treatment of data. Paul’s discussion of
identification illustrates how macroeconomics needs to use all the
hard information it can get to parameterise its models. Yet
microfounded models, the only models deemed acceptable in top journals for both theoretical and empirical analysis, are normally rather selective about the data they
focus on. Both micro and macro evidence is either ignored because it
is inconvenient, or put on a to do list for further research. This is
an inevitable result of making internal consistency an admissibility
criteria for publishable work.

The second vulnerability is a conservatism which also arises from
this methodology. The microfoundations criteria taken in its strict
form makes it intractable to model some processes: for example
modelling sticky prices where actual menu costs are a deep parameter.
Instead DSGE modelling uses tricks, like Calvo contracts. But who
decides whether these tricks amount to acceptable microfoundations or
are instead ad hoc or implausible? The answer depends a lot on
conventions among macroeconomists, and like all conventions these
move slowly. Again this is a problem generated by the
microfoundations methodology.

Paul’s discussion of real effects from monetary policy, and the
insistence on productivity shocks as business cycle drivers, is
pretty dated. (And, as a result, it completely misleads Paul Mason
here.)
Yet it took a long time for RBC models to be replaced by New
Keynesian models, and you will still see RBC models around. Elements
of the New Classical counter revolution of the 1980s still persist in some places. It
was only a few years ago that I listened to a seminar paper where the
financial crisis was modelled as a large negative productivity shock.

Only in a discipline
which has deemed microfoundations as the only acceptable way of
modelling can practitioners still feel embarrassed about including
sticky prices because their microfoundations (the tricks mentioned
above) are problematic . Only in that discipline can respected
macroeconomists argue
that because of these problematic microfoundations it is best to ignore
something like sticky prices when doing policy work: and argument
that would be laughed out of court in any other science. In no other
discipline could you have a debate
about whether it was better to model what you can microfound rather
than model what you can see. Other economists understand this, but
many macroeconomists still think this is all quite normal.

Monday, 19 September 2016

One of the annoying aspects of the Brexit debate is that every piece
of macroeconomic news, every survey or data point, is interpreted as
evidence one way or another about the economic costs of Brexit. The
problem with this is partly that Brexit has not happened yet, but more
fundamentally the important costs of Brexit were always long term.
The Treasury’s analysis
of the permanent costs of Brexit looked 15 years ahead, because that
is the kind of time period over which the full impacts will be felt.

That has another annoying implication, which is that it will be very
difficult to ever know what the actual costs of Brexit will have
been. GDP being 6% lower after 15 years (the Treasury’s central
estimate based on a bilateral trade agreement) will have a noticeable
impact on economic growth, but who knows what the counterfactual is?
As I have noted many times, the trend growth in UK GDP per capita was
a remarkably steady 2.25% until the financial crisis, but since then
productivity growth has collapsed, so who knows what it might have
been without Brexit.

It is true that with rational expectations the future will have an
impact on the present. That is why the exchange rate fell sharply on
news of the vote. As I keep pointing out, unless those in the markets
change their minds, that depreciation makes every UK resident poorer, perhaps
forever. Equally if everyone anticipated that their future income
will be lower they should reduce consumption now. But one reason the
vote went the way it did is that many people did not believe that
Brexit will have a long run negative impact on their standard of living.

We can make the same point in a more concrete way by thinking about
the problem facing the OBR as it makes its forecast before the Autumn
Statement in November. Those expecting to see something dramatic in
these forecasts may be disappointed, partly because Brexit is likely
to actually occur in the middle of the OBR’s 5 year forecasting
period. Where the OBR will have to come clean about their view on the
long term impact of Brexit will not be until next summer, when it
does its 50 year ahead projections.

While these long term costs were always what really mattered, I have
the impression (see also Paul Krugman) that the campaign spent much
more time talking about short run impacts. As I have argued, these
could be significant but are much more uncertain because they are
more complicated. (How much will the depreciation boost net exports,
for example?) So why was there so much focus on the short term in the
campaign, and why did some (mainly politicians) start talking about
Brexit creating a short term crisis?

I suspect (and this is just a guess) that one reason is that talk
about long run costs had little impact in the media and on voters.
(This is what the polls suggest: voters seemed more prepared to agree
that there might be short run costs to Brexit.) To an economist that
seems odd, because the economics behind the long term impact is much
more solid than what might happen in the short run. Of course Keynes
had a famous phrase about all being dead in the long run, but as
Simon Taylor points
out he made that comment to counteract a tendency for some to dismiss
problems like unemployment caused by recessions as unimportant
because it will disappear in the long run.

One suggestion I have seen links the lack of traction over long run costs to the fact that Leave voters
tended to be older, and therefore that they did not care too much about the
long run. I think this is unfair: most of those older voters also
have children who they care about.

I suspect the problem came from a basic misunderstanding that was
deliberately encouraged by the Leave campaign, which is to see all
economic analysis as an unconditional macroeconomic forecast. The
retort ‘who knows what will happen in 15 years time’ resonates if
that is what you are familiar with. Too many people who should have
known better, or perhaps chose not to know better, failed to make the
distinction between conditional and unconditional forecasts. We had
the ridiculous charge that the Chancellor should not have said people
will be worse off in 15 years time, because with normal growth in absolute terms they
probably will not be.

To see how nonsensical this framing is, think about the advice any
doctor will give you that by smoking you will be worse off. Society
does not collectively shrug that off by saying who knows what will
happen in 10 or more years time. Except of course some teenagers do
say this and come to regret it. Nor, by the way, do people tell
medics that they failed for decades to predict that smoking would
kill people so why should we take any notice now. We are completely familiar with doctors giving us conditional forecasts, but for some reason some in the media kept trying to view any analysis of long term Brexit costs as another unconditional macroeconomic forecast. [1]

One implication of this is that the consequences of Brexit may never
become obvious, particularly to those who voted to Leave. Of course economists will do the best they can with the data, but I doubt very
much that their analysis will get through to most people. One of the
many sad aspects of the Brexit decision is that those who helped make
it possible will never be held responsible for their actions.

[1] Note also that these long term Brexit costs essentially came from empirical studies with fairly common sense theoretical content well grounded in evidence.

Friday, 16 September 2016

As I do not win prizes very often, I thought I would use the occasion
of this one
to write something much more personal than I normally allow myself.
But this mini autobiography has a theme involving something quite
topical: the relationship between academic macroeconomics and
reality, and in particular the debate over DSGE modelling and the
lack of economics in current policymaking. [1]

I first learnt economics at Cambridge, a department which at that
time was hopelessly split between different factions or ‘schools of
thought’. I thought if this is what being an academic is all about
I want nothing to do with it, and instead of doing a PhD went to work
at the UK Treasury. The one useful thing about economics that
Cambridge taught me (with some help
from tutorials with Mervyn King) was that mainstream economics
contained too much wisdom to be dismissed as fundamentally flawed,
but also (with the help of JohnEatwell)
that economics of all kinds could easily be bent by ideology.

My idea that by working at the Treasury I could avoid clashes between
different schools of thought was of course naive. Although the
institution I joined had a well developed and empirically orientated
Keynesian framework [2], it immediately came under attack from
monetarists, and once again we had different schools using different
models and talking past each other. I needed more knowledge to
understand competing claims, and the Treasury kindly paid for me to
do a masters at Birkbeck, with the only condition being that I
subsequently return to the Treasury for at least 2 years. Birkbeck at
the time was also a very diverse department (incl JohnMuellbauer,
RichardPortes,
RonSmith,
BenFine
and LaurenceHarris),
but unlike Cambridge a faculty where the dedication to teaching
trumped factional warfare.

I returned to the Treasury, which while I was away saw the election
of Margaret Thatcher and its (correct) advice about the impact of monetarism completely rejected. I was, largely by accident, immediately thrust
into controversy: first by being given the job of preparing a
published paper evaluating the empirical evidence for monetarism, and
then by internally evaluating the economic effects of the 1981
budget. (I talk about each here
and here.)
I left for a job at NIESR
exactly two years after I returned from Birkbeck. It was partly that
experience that informed this post
about giving advice: when your advice is simply ignored, there is no
point giving it.

NIESR was like a halfway house between academia and the Treasury:
research, but with forecasting rather than teaching. I became very
involved in building structural econometric models and doing
empirical research to back them up. I built the first version of what
is now called NIGEM
(a world model widely used by policy making and financial
institutions), and with StephenHall
incorporated rational expectations and other New Classical elements
into their domestic model.

At its best, NIESR was an interface between academic macro and
policy. It worked very well just before 1990, where with colleagues I
showed
that entering the ERM at an overvalued exchange rate would lead to a
UK recession. A well respected Financial Times journalist responded
that we had won the intellectual argument, but he was still going
with his heart that we should enter at 2.95 DM/£. The Conservative
government did likewise, and the recession of 1992 inevitably
followed.

This was the first public occasion where academic research that I had
organised could have made a big difference to UK policy and people’s
lives, but like previous occasions it did not do so because others
were using simplistic and perhaps politically motivated reasoning. It
was also the first occasion that I saw close up academics who had not
done similar research but who had influence use that influence to
support simplistic reasoning. It is difficult to understate the
impact that had on me: being centrally involved in a policy debate,
losing that debate for partly political reasons, and subsequently
seeing your analysis vindicated but at the cost of people becoming
unemployed.

My time at NIESR convinced me that I would find teaching more
fulfilling than forecasting, so I moved to academia. The publications
I had produced at NIESR were sufficient to allow me to become a
professor. I went to Strathclyde University at Glasgow partly because
they agreed to give temporary funding to two colleagues at NIESR to
come with me so we could bid to build a new UK model. [3] At the time
the UK’s social science research funding body, the ESRC, allocated
a significant proportion of its funds to support econometric
macromodels, subject to competitions every 4 years. It also funded a
Bureau
at Warwick university that analysed and compared the main UK models.
This Bureau at its best allowed a strong link between academia and
policy debate.

Our bid was successful, and in the model called COMPACT
I would argue we built the first UK large scale structural
econometric model which was New Keynesian but which also incorporated
innovative features like an influence of (exogenous) financial
conditions on intertemporal consumption decisions. [4] We
deliberately avoided forecasting, but I was very pleased to work with the IPPR
in providing model based economic analysis in regular articles in
their new journal, many written with RebeccaDriver.

Our efforts impressed the academics on the ESRC board that allocated
funds, and we won another 4 years funding, and both projects were
subsequently rated outstanding by academic assessors. But the writing
was on the wall for this kind of modelling in the UK, because it did
not fit the ‘it has to be DSGE’ edict from the US. A third round
of funding, which wanted to add more influences from the financial
sector into the model using ideas based on work
by Stiglitz and Greenwald, was rejected because our approach was ‘old
fashioned’ i.e not DSGE. (The irony given events some 20 years
later is immense, and helped inform this paper.)

As my modelling work had always been heavily theory based, I had no
problem moving with the tide, and now at Exeter university with
CampbellLeith
we began a very successful stream of work looking at monetary and
fiscal policy interactions using DSGE models. [5] We obtained a
series of ESRC grants for this work, again all subsequently rated as
outstanding. Having to ensure everything was microfounded I think
created more heat than light, but I learnt a great deal from this
work which would prove invaluable over the last decade.

The work on exchange rates got revitalised with Gordon Brown’s 5
tests
for Euro entry, and although the exchange rate with the Euro was
around 1.6 at the time, the work I submitted to the Treasury implied
an equilibrium rate closer to 1.4. When the work was eventually
published
it had fallen to around 1.4, and stayed there for some years. Yet as
I note here,
that work again used an ’old fashioned’ (non DSGE) framework, so
it was of no interest to journals, and I never had time to translate
it (something Obstfeld and Rogoff subsequently did, but ignoring
all that had gone before). I also advised the Bank of England on
building its ‘crossover’ DSGE/econometric model (described here).

Although my main work in the 2000s was on monetary and fiscal policy,
the DSGE framework meant I had no need to follow evolving macro data,
in contrast to the earlier modelling work. With Campbell and Tatiana
I did use that work to help argue for an independent
fiscal council in the UK, a cause I first argued
for in 1996. This time Conservative policymakers were listening, and
our paper helped
make the case for the OBR.

My work on monetary and fiscal interaction also became highly
relevant after the financial crisis when interest rates hit their
lower bound. In what I hope by now is a familiar story, governments
from around the world first went with what macroeconomic theory and
evidence would prescribe, and then in 2010 dramatically went the
opposite way. The latter event was undoubtedly the underlying
motivation for me starting to write this blog (coupled with the
difficulty I had getting anything I wrote published in the Financial
Times or Guardian).

When I was asked to write an academic article
on the fiscal policy record of the Labour government, I discovered
not just that the Coalition government’s constant refrain was
simply wrong, but also that the Labour opposition seemed uninterested
in what I found. Given what I found only validated what was obvious
from key data series, I began to ask why no one in the media appeared
to have done this, or was interested (beyond making fun)
in what I had found. Once I started looking at what and how the media
reported, I realised this was just one of many areas where basic
economic analysis was just being ignored, which led to my inventing
the term mediamacro.

You can see from all this why I have a love/hate relationship to
microfoundations and DSGE. It does produce insights, and also ended
the school of thought mentality
within mainstream macro, but more traditional forms of macromodelling
also had virtues that were lost with DSGE. Which is why those who
believe microfounded modelling is a dead end are wrong: it is an
essential part of macro but just should not be all academic macro.
What I think this criticism can do is two things: revitalise
non-microfounded analysis, and also stop editors
taking what I have called
‘microfoundations purists’ too seriously.

As for macroeconomic advice and policy, you can see that austerity is
not the first time good advice has been ignored at considerable cost.
And for the few that sometimes tell me I should ‘stick with the
economics’, you can see why given my experience I find that rather
difficult to do. It is a bit like asking a chef to ignore how bad the
service is in his restaurant, and just stick with the cooking. [6]

[1] This exercise in introspection is also prompted by having just
returned from a conference in Cambridge, where I first studied
economics. I must also admit that the Wikipedia page on me is
terrible, and I have never felt it kosher to edit it myself, so this
is a more informative alternative.

[2] Old, not new Keynesian, and still attached to incomes policies.
And with a phobia about floating rates that could easily become ‘the
end is nigh’ stuff (hence 1976 IMF).

[3] I hope neither regret their brave decision: JuliaDarby
is now a professor at Strathclyde and JohnIreland
is a deputy director in the Scottish Government.

[4] Consumption was of the Blanchard Yaari type, which allowed
feedback from wealth to consumption. It was not all microfounded and
therefore internally consistent, but it did attempt to track
individual data series.

[5] The work continued when Campbell went to Glasgow, but I also
began working with TatianaKirsanova
at Exeter. I kept COMPACT going enough to be able to contribute to
this article
looking at flu pandemics, but even there one referee argued that the
analysis did not use a ‘proper’ (i.e DSGE) model.

[6] At which point I
show my true macro credentials in choosing analogies based on
restaurants.

Monday, 12 September 2016

It is with a dreadful sense of inevitability that I’m watching what is happening in the US general election between Clinton and Trump. Just as the media in the UK normalised the flat out lies of the Brexit campaign, so the media in the US is normalising Donald Trump.

In both cases this stems from an obsession with balance. With the Brexit campaign the media balanced the lie about £350 million a week to the NHS with Remain’s claims (based on analysis using consensus economics) about the economic damage that leaving the single market would do. With the US general election, Trump's stream of well documented lies are balanced against seemingly baseless insinuations about Clinton.

This is not about what you read in the New York Times or the Washington Post. Their audience is generally not the electorate that could vote either way. The Financial Times provided exemplary coverage of Brexit issues, and the non-tabloid press as a whole was not too bad. With Brexit the critical electorate were those that read the tabloid press, just as in the US it is those that watch cable news. Those sources deliberately and relentlessly distort news to favour one side.

Without major changes to how the media is regulated in the US and how the press is regulated in the UK, there is little that can done about this particular media bias against truth. So the best we can hope for in the meantime is that the big ticket events like debates, or widely watched programmes on the non-partisan media like the evening TV news in the UK, offer some redress to the partisan nature of much of the media. Which is why the failure of Matt Lauer in questioning the two candidates is so important.

The concept of balance needs to be rethought by media organisations. Facts, and lies about them, should be above balance. The consensus views of experts like academics should be above balance. Standing up for both is not a journalist expressing an opinion, but a journalist doing their job.

The media likes to think of itself as the protector of free speech, and of holding authority to account. But that matters little if at crucial points in the democratic process the media either distorts reality or hides the truth. If you think that is an exaggeration, how else could you possibly get a result like this:

“Trump has his largest edge of the campaign as the more honest and trustworthy of the two major candidates (50% say he is more honest and trustworthy vs. just 35% choosing Clinton)”

If you are reading this in the UK and thinking this could only happen in the US, who do you think was trusted during the Brexit campaign?